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Crisis, what crisis - Darling's in control
For the past year the question I have been asked most often is why should the problems with sub prime mortgages in the US affect us here in the UK, and without wishing to add any more doom and gloom to this subject, we have in fact, reached a critical stage in this sorry saga.
As many readers will already know, the sub prime debacle refers to loans made by banks and finance houses to people with poor credit histories. The banks took a strategic decision to target this particular group of consumers, as they could borrow at cheap rates from other banks and countries, and sell the mortgages at a higher rate. Once the money had been loaned out at higher than average interest rates, the banks then sliced and diced the loans and sold them on into the bond, and other markets, in order to spread their risk. They also managed to persuade the various regulators and insurers that these “investments” were triple AAA rated. The strategy is not dissimilar to buying up rancid chicken, passing it through a saline solution, and selling it on as a grade A product.
Such a strategy could have continued had the world economy not started to overheat, and central banks been forced to raise interest rates, at which point the sub-prime borrowers, already paying vastly inflated interest rates, suddenly found their mortgage repayments increase exponentially. In a recent programme, one home owner in the US found her mortgage increase to 18% even as the US Federal Reverse was slashing interest rates at the fastest rate ever. Here in the UK the most immediate result last year was the run on Northern Rock. They too were funding their mortgage lending, not from depositors’ accounts, but from other banks and countries such as Japan; This shuddered to a halt once all the banks closed down their lines of credit when they began to realise the scale of their problems. Even as I write Northern Rock has now been officially nationalised by the government, although we are not allowed to mention the N word according to Mr Darling!!
It is estimated that sub prime losses are in the region of $500bn, of which only $200bn has been accounted for so far. It is suspected that it is the Japanese banks that are carrying the remainder, but we will have to wait until March for the truth to emerge, when the banks publish their figures under Japan’s new strict audit regulations. At this point we can expect the “credit crunch” to bite even more as it has been the Japanese Yen which has been funding our massive corporate and personal credit binge. There is already evidence to suggest that the Japanese banking system has started to tighten, and banking shares and the Nikkei have been plunging since Christmas. It feels like the lull before the storm.
The days of easy credit and low interest rates did not just spark our own housing bubble, but also fuelled a spectacular boom in the commercial property sector. Overall the retail sector achieved a whopping 60.5% gain in the three years to 2007. But now the boom is officially over as the average yield (the amount of rent paid compared with the purchase price) stands well below the bank’s base rate. Morgan Stanley predicts the market to fall by 50% and when desperate investors are prevented from taking their own money from funds and bonds, the writing is well and truly on the wall.
However, it is the domestic market which is of most concern as the removal of easy credit and low interest rates will result in the market either stagnating or slumping. The two small interest rate reductions so far from the BOE are woefully inadequate. Experts are currently predicting falls in the domestic market anywhere between 3% and 20%. Further evidence that the market is due a “correction” includes the fact that the average house is now worth an extraordinary 9 times average earnings. The long-term average is just 3.5. RICS announced last month that December 2007 was the worst month for the housing market since the recession of 1992. In 1993 first time buyers made up 55% of the market, but that figure has now collapsed to 29%. In May 2007 Jon Hunt, founder of Foxtons sold the arm of his UK business – a very smart move!
To add to this gloom we have growing inflation in energy and food, which are allegedly preventing the BOE from lowering interest rates at a faster rate, but this attitude has been compared to that of Nero fiddling while Rome burns. The cumulative effect of these issues will be a further clampdown on personal and commercial lending, rising bankruptcies, and increasing numbers of house repossessions.
Needless to say there are sectors which will thrive in this financial environment, because for every loser there will be a winner, and in trading or investing the trick is to ensure you position yourself on the right side of the market as often as possible.
My investing tips for 2008 range from good old fashioned national savings for nervous investors to utility and energy sectors especially if option contracts pricing oil at $200 a barrel in 2008 are to be believed. Precious metals too will continue to attract investors and my own tip is palladium. This year will also see renewed interest in soft commodities such as wheat, corn, and soybeans and I shall be explaining how to trade and invest in these markets in subsequent articles. Meanwhile it’s flak jackets and tin hats while we wait for the financial firestorm to burn itself out.
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